Short Answer Sections (3 questions – 30 points total)
Suppose that coffee beans are produced in a perfectly competitive, constant cost, industry. The diagrams below show short run supply and demand for the industry as a whole and the marginal cost for a typical coffee grower (assume all firms are identical in this industry).
Coffee Growing Industry Representative Coffee Growing Firm
100,000’s pounds of coffee beans per day pounds of coffee beans per day
A) To the firm (grower) diagram, add the demand and MR curves faced by the firm. Assuming that this firm is in long run equilibrium, add the long run industry supply (LRIS) curve to the industry diagram. How many pounds of coffee beans is each firm producing? What is the average total cost at this quantity? Fill in the blanks.
Yellow line = LRIS (constant cost industry) Pink line = D = MR (firm)
q* = _____45_______ ATC at q* = ____$2.50__(in LR eqm, P=ATC=MC at q*)___
B) Suppose the American Medical Association publishes a study that shows that drinking coffee causes ulcers, and thus consumers buy 15 less 100,000’s pounds of coffee at any given price than before. Assuming that this firm wants to continue producing in the short run, how many pounds of coffee will the firm produce, and at what price?
Market demand shifts left so firm demand falls in SR
q** = ____around 37.5 lbs_________ P** = ______around $2.25_______________
C) Briefly describe how the coffee industry will move to a new long run equilibrium. In your discussion you must include 1) whether firms will exit or enter the industry, 2) how does the quantity each firm produces (q) change, 3) whether there are shifts in the firm’s cost curves and demand curves and movement of industry supply. In the new long run equilibrium, how many pounds of coffee beans will the market will produce (Q) and at what price (P) it will be sold?
With lower P in short run, some firms will earn losses and have to exit in the LR; Exit causes short run industry supply (S) to shift left, to meet new lower D curve (at original P = $2.50, due to constant costs in LR). Cost curves do not shift, firm D increases over time back to $2.50 (due to firms exiting) and firms q returns to q* = 45 (fewer firms but producing same amount in LR). Market Q in LR falls to 30 (x100,000) pounds of coffee.
Question 2 (8points)
A. Circle the right word to complete the following statements.
a. Exit of firms from the milk industry will cause the market supply / demand (circle one)
for milk to shift right / shift left / not change (circle one).
b. If it cost Ford $400 million in 1999 to produce 10,000 cars and it cost Ford $900 million
in 2009, to produce 30,000 cars, then the firm is experiencing
economies / diseconomies / constant returns (circle one) to scale.
c. Easy entry and exit of firms in perfect competition lead to
perfectly elastic demand / zero long run profit / short run losses (circle one)
for perfectly competitive firms.
B. Fill in the blanks.
a. Marginal ___revenue or cost_____ is used to determine the